The Relevance Of An ECN Broker In Pure Direct Market Access Trading
Professional investors usually prefer to trade the different financial products through direct market access channels, which grant them unparalleled access to the financial markets without any interference from the middle man. Almost all transactions in the financial industry are routed through brokerage houses, which help in mediating the best price between buyers and sellers. Traders can open orders at market prices by tapping into the liquidity provided by global liquidity providers, which is further made easy by the technological advancements of the 21st century. Nowadays, almost all financial transactions are transmitted through electronic means, which also gave rise to the ECN protocol, known as the Electronics Communications Network (ECN). ECN brokers are direct market access companies that connect traders directly to interbank markets for the best in price matching, liquidity, and speed of order execution.
However, the financial markets used to be an exclusive investment opportunity that only catered to the wealthy and affluent, particularly due to the insane amount of volumes required to purchase stocks. Around the second part of the 20th century, several independent companies realized the need for smaller traders to enter the market as speculators and started offering brokerage services through a concept that became popularly known as bucket shops.
Bucket shops are highly concentrated trading houses that do not pass orders to the market; instead, they are filled internally by dealers working through dedicated dealing desks. In spite of the numerous scams, financial irregularities, and regulatory disciplinary actions, bucket shops continued to grow in popularity among smaller retail traders, who now had an opportunity to speculate in the market using a minuscule trading capital. Several countries have put serious restrictions on the operations of bucket houses, with some countries even choosing to ban the entire concept of bucket shop trading. Nevertheless, these brokers are still popular in the modern financial markets, albeit they are far and few when compared to a few years ago.
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ECN In Forex Trading
Forex trading is one of the newest investment opportunities that take the concept of bucket shop trading to another level. More commonly known as market makers, conventional Forex brokers have a manual or automated dealing desks that work on behalf of traders to match orders internally. The currency market sees transactions on currency pairs that involve buying and selling currencies with respect to one another; therefore, a currency pair should have a buy side and sell side for a successful order transaction. To facilitate the acceptance of a trade order, a market maker broker will search for traders that are willing to take the opposite end of the trade, thereby completing the order process internally. If a broker cannot match orders internally, they may either choose to take the opposite end of the trade themselves, or are at liberty to reject the order altogether.
Market maker brokers may act as a counterparty of a client’s order, which gives rise to a conflict of interest between a broker and its client. The very conflict of interest and the lack of access to global liquidity prevent traders from transacting large volumes in the Forex markets through market makers. Therefore, brokers have started providing ECN protocols that are designed to offer direct market access trading by connecting traders directly to global liquidity providers. ECN brokers are not required to guarantee the execution of order, as all orders are passed to interbank liquidity providers, where orders are filled according to the existing liquidity. Global liquidity providers have access to multiple brokers and trading houses, which allow them to match orders during most market hours. Unlike market maker brokers, ECN brokers can guarantee partial filling of orders, which may lead to substantial slippages between the strike price and the entry/exit point.
Electronic Communications Network has helped in making FX trading far more attractive for professional investors, who can now tap into the incredible liquidity of the FX markets without worrying about requotes or order cancellations. Even smaller traders are starting to realize the numerous benefits of ECN trading, which is further promoted by ECN Forex brokers through smaller accounts that make ECN accounts accessible for all.
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How Do ECN Forex Brokers Facilitate Trading In The Trillion Dollar Forex Market?
ECN works by connecting a trader’s Forex platform to an interbank exchange or liquidity provider such as banks and exchange houses, where orders are transmitted to global clearing houses through dedicated ECN bridges. Unlike market maker brokers, ECN brokers offer instantaneous pricing and access to vital information such as market depth and other prime factors, which enable traders to have a better understanding of the existing liquidity in the markets.
Once a trader connects his ECN terminal to the markets, he receives direct market pricing from the liquidity providers without any intervention from the broker. All aspects of trading such as spreads, SWAPs, and other trading costs are determined according to the existing volumes in the market, which means that the broker has no control over the pricing of the currency pairs. Market maker brokers may stipulate fixed or floating spreads that have a minimum spread of 1 pip on major currency pairs, but due to the increased liquidity in the ECN markets, ECN FX brokers can promise spreads starting from 0 pips. It is normal for the bid and ask price to have no spreads during several market conditions, which allows scalpers and high-frequency traders to take advantage of the 0 pips spread offering. To compensate for the loss in spreads, brokers might charge a commission per trade, which can cost anywhere from $2 to $50 per round lot traded or a percentage of the invested capital.
Once a trader sends his order through an ECN platform, the liquidity providers match their orders at market price by finding counterparties to their trade order. If there isn’t sufficient liquidity in the markets, traders might receive a partial fill, but there are no requotes or order cancellations that are more prominent among market maker brokers. The same happens while closing the trade as well, where orders must be matched to other parties that are looking to take the counterpart of the order. The Forex market sees an average daily transaction volume in the range of 6 trillion US dollars, which virtually guarantees that the market has the liquidity and the market depth to accommodate almost all volumes at different market prices.
What Are The Advantages Of ECN Forex Accounts?
ECN accounts are more preferred by traders than regular market maker accounts, essentially owing to a large number of trading advantages on offer. Here are some of the main benefits of choosing an ECN brokerage account:
- Direct Market Access trading with no conflict of interest with the broker – Due to the direct market access nature of ECN accounts, traders can be totally assured that their broker will not trade against their positions. Reduced conflict of interest also means that your trading capital will be more secure against dealer manipulation.
- Low Spreads & Cost Of Trading – ECN accounts have the tightest spread among all different types of trading accounts, as spreads start from 0 pips. High-frequency traders can enjoy better returns on their investments and need not worry about large swings in spreads during news trading, which is an added advantage for scalpers and short-term traders.
- Price Guarantee – ECN brokers guarantees to match the best price in the markets, which are directly provided by the liquidity providers. ECN brokers offer some of the most favorable pricing and trading conditions in the market, which is why ECN is far more attractive than other leading trading protocols.
- The Speed of Execution – ECN Forex accounts have faster execution times, which guarantees even better latency with a VPS option. All orders are passed to the market instantaneously, and the orders are filled at a fraction of a second.
- No Limits To Trading – Since the FX market is worth over 6 trillion dollars a day, it is possible for traders to open large positions in the market without distressing about the liquidity and volumes. Market maker brokers often specify maximum trade limits for orders such as the maximum number of lots and a maximum number of positions, but ECN brokers don’t have any such stipulations. Traders are free to open as many positions as they like, provided they have sufficient margin in their account according to the margin requirements of the broker.
- Important Information Related To Market Depth – ECN accounts offer advanced market information such as market depth, buy orders, and sell orders, which help traders to be better prepared while investing in the market.
What Are Some Of The Obvious Drawbacks Of Trading On ECN Accounts?
ECN Forex accounts do have a few issues that may prevent traders from enjoying a seamless trading environment. Traders that are making a switch from the market maker protocol to the ECN protocol may find it difficult to adjust their trading style to suit ECN trading requirements. Here are a few disadvantages of choosing an ECN Forex broker:
- Commissions along with Spreads – While market maker brokers have a fixed cost per trading that is usually dependent on the floating spreads, ECN trading has flexible costs that have both spreads, as well as a commission per trade. Although the commission is a fixed cost of trading, the spreads may fluctuate according to market conditions, which may sometimes increase by more than the standard 3 pips or 5 pips that are expected from a similar market maker account. Therefore, traders may have to spend more in ECN trading than they may spend in regular market maker accounts.
- Partial Filling of Orders & Slippage – ECN trading guarantees the filling of orders, and does not induce requotes or order cancellations. The downside to this feature is the incredible amount of slippage and partial fills, which may lead to the trader being in the market at the wrong price. The currency markets are known to move significantly over the span of a few seconds, which can induce large slippages that can take an amateur trader off-guard. Be extremely careful about slippages during your initial days trading with ECN Forex brokers.
- Market Volatility – One of the primary advantages of the ECN account can also turn into a disadvantage for traders that use high leverage for their trading strategies. Market volatility and slippages usually induce margin calls for over-leveraged accounts, especially due to the direct market access pricing and instant volatility. Therefore, smaller traders should be cautious about their trading capital, and try to use manageable leverage for preserving your trading capital.
How To Control Your Costs In ECN Forex Trading
It ‘s hard to control the cost of FX trading without being proactive in your trading approach. There are different types of fees and commissions of trading that can quickly lead to a massive amount of losses right off the bat. The spreads, commissions, and SWAPs are some of the most common costs of trading that can result in at least 5% drawdown if a trader uses his entire account equity on a single position. Therefore, position sizing and money management are vital to reducing your cost of trading and for increasing your chance of profits.
The choice of your ECN Forex broker also plays a significant role in reducing your trading costs. Some ECN brokers offer ultra-tight spreads and commissions of $2 per round lot traded, while there are brokers that are known to mark up their commissions as spreads and other costs of trading. Other dishonest brokers may also charge up to $50 commission per round lot, along with spreads that are significantly larger than market maker brokers. Therefore, take your time to analyze different ECN Forex brokers, and find a reliable trading partner that can offer you the best trading conditions at the least costs.
ECN Brokers & Their Minimum Margin Requirements
ECN trading accounts, being DMA accounts, required traders to deposit a significant sum of money as trading capital to trade at interbank rates. However, brokers are now offering higher leverage and lower margin requirements to enable smaller traders to take advantage of the ECN trading conditions using a considerably lower initial deposit. As a trader, you can open an ECN account for just $100, while micro ECN accounts are available for as little as $1. Even with a leverage of 1:1000, we do believe that $1 or even $100 as trading capital may lead to a risky trading strategy, which will eradicate your trading capital with one large movement. ECN accounts are notorious for slippages, which can also result in a substantial loss at the time of opening an order at market conditions.
It would be preferable to start with at least a $1000 minimum trading capital, along with a maximum leverage of 1:100, so as to take full advantage of an ECN account. Such a trading strategy will help a trader to weather out market volatility and helps investors to minimize their losses without succumbing to margin calls or massive losses.
Popular ECN Forex Trading Platforms In The Market
There are a number of different ECN platforms such as the cTrader, the MT4, the MT5, and other lesser known platforms such as Fortex and jTrader. The MetaTrader terminal uses ECN bridges to connect traders to an ECN liquidity provider, while the cTrader is designed from the ground up to be a dedicated ECN trading terminal. Some brokers also design and develop their own proprietary ECN trading software to provide custom-tailored solutions for their clients.
ECN trading is a great form of investments for professional traders and institutional firms. An ECN account is relatively free from broker manipulation and offers direct market access that is guaranteed to provide the best trading environment for all types of traders. As a word of caution, new traders should get familiar with an ECN trading platform with a demo account, before switching to a live trading account, as ECN trading conditions are entirely different from the market maker or dealing desk conditions. Practicing with an ECN demo account can indeed help you to prepare yourself better for all the features and functionalities offered on real-life ECN trading accounts.